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Part 6 Chapter 14 Financing the Enterprise © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. CHAPTER 14 Accounting and Financial Statements CHAPTER 15 Money and the Financial System CHAPTER 16 Financial Management and Securities Markets APPENDIX D Personal Financial Planning © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 2 Learning Objectives LO 14-1 Define accounting and describe the different uses of accounting information. LO 14-2 Demonstrate the accounting process. LO 14-3 Examine the various components of an income statement to evaluate a firm’s bottom line. LO 14-4 Interpret a company’s balance sheet to determine its current financial position. LO 14-5 Analyze the statement of cash flows to evaluate the increase and decrease in a company’s cash balance. LO 14-6 Assess a company’s financial position using its accounting statements and ratio analysis. © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 3 The Nature of Accounting • Accounting – The recording, measurement and interpretation of financial information • Certified Public Accountant – An individual who has been state certified to provide accounting services ranging from the preparation of financial records and the filing of tax returns to complex audits of corporate financial records © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 4 Prestige Rankings of Accounting Firms 2015 Rank 2014 Rank Company 1 1 (PricewaterhouseCoopers) LLP 2 2 Ernst & Young LLP 3 3 Deloitte LLP 4 4 KPMG LLP 5 5 Grant Thornton LLP 6 6 McGladrey LLP 7 7 BDO USA LLP 8 8 Crowe Horwath LLP 9 9 Moss Adams LLP 10 10 Baker Tilly Virchow Krause © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Legislation o After the accounting scandals of Enron and Worldcom in the early 2000s, Congress passed – Sarbanes-Oxley Act – required firms to be more rigorous in their accounting and reporting practices o During the latest financial crisis, banks developed questionable lending practices, leading to – Dodd Frank Act – strengthens the oversight of financial institutions © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Accounting Standards (1 of 2) Public and private businesses follow the Generally Accepted Accounting Principles (GAAP) method GAAP is generally used in the United States as the standard for accounting methods (established by the Financial Accounting Standards Board (FASB)) Local government entities have a different set of accounting standards which are set by the Governmental Accounting Standards Board (GASB) © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Accounting Standards (2 of 2) Federal government follows yet another set of standards determined by the Federal Accounting Standards Advisory Board (FASAB) Another set of standards for international companies which follow the International Financial Reporting Standards (IFRS) © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Forensic Accounting Accounting that is fit for legal review Involves analyzing financial documents in search of fraudulent entries or financial misconduct Function as much as detectives as accountants Used since the 1930s Booming since the accounting scandals of the early 2000s Root out evidence of “cooked books” for federal agencies © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 9 Private Accountants Private Accountants – Employed by large corporations, government agencies, and other organizations to prepare and analyze their financial statements – Deeply involved in most of the most important financial decisions of the organization Certified Management Accountants (CMAs) – Private accountants who are certified by the National Association of Accountants and who have some managerial responsibility © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Accounting or Bookkeeping? Bookkeeping is typically limited to the routine, dayto-day recording of business transactions Much narrower and far more mechanical than accounting Require less training than accountants Responsible for obtaining and recording the information accounts require to analyze a firm’s financial position Accountants usually complete course work beyond their basic 4 or 5 year college degree © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Users of Accounting Information (1 of 3) • Managers and owners use financial statements: 1. Aid in internal planning and control 2. External purposes such as reporting to the Internal Revenue Service, stockholders, creditors, customers, employees, and other interested parties © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Users of Accounting Information (2 of 3) • Organizational Use Board of Directors Owners, shareholders Managers Management Information Systems Business research Internal control © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Users of Accounting Information (3 of 3) • Stakeholder Use Tax collecting agencies Regulatory agencies Special interest groups Customers Financial analysis Employees Media © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Internal Uses of Accounting Information Managerial Accounting – The internal use of accounting statements by managers in planning and directing the organization’s activities Cash Flow – The movement of money through an organization over a daily, weekly, monthly or yearly basis Budget – An internal financial plan that forecasts expenses and income over a set period of time © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. External Uses of Accounting Information Used for filing income taxes, obtaining credit and reporting results to stockholders Annual Report A summary of a firm’s financial information, products, and growth plans for owners and potential investors Audited financial statements are those signed off on by a certified public accountant © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Greece and Deceptive Accounting Practices During global financial crisis, Greece was engaging in deceptive accounting practices with the help of U.S. investment banks ♦ Used financial techniques to hide massive amounts of debt from its public balance sheet ♦ Eventually markets discovered the country might not be able to pay off its creditors ♦ European Union and International Monetary Fund gave some credit relief PIGS (Portugal, Italy, Ireland, Greece, Spain) all had debt problems Germany demanded austerity, but others wanted more growthoriented strategies © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Banks and Financial Statements Wells Fargo specializes in banking, mortgage, and financial services Data it provides can be used in financial statements Short-term lender examines a firm’s cash flow to assess its ability to repay a loan quickly with cash generated from sales Long-term lender more interested in the company’s profitability and indebtedness to other lenders © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. The Accounting Equation Assets = Liabilities + Owner’s Equity Assets o A firm’s economic resources, or items of value that it owns, such as cash, inventory, land, equipment, buildings, and other tangible and intangible things Liabilities o Debts that a firm owes to others Owner’s Equity o Equals assets minus liabilities and reflects historical values © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Owner’s Equity The owner’s equity portion of a company’s balance sheet: ► Rendezvous Barbecue in Memphis, TN ► Includes the money the company’s owners have put into the firm © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Double-Entry Bookkeeping • A system of recording and classifying business transactions that maintains the balance of the accounting equation Balance: To keep the accounting equation in balance, each transaction must be recorded in two separate accounts Classification: All business transactions are classified as either assets, liabilities, or owner’s equity Break Down: Assets broken down into cash, inventory and equipment; Liabilities broken down into bank loans, supplier credit, and other debts © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 21 The Accounting Cycle (1 of 2) ►The four-step procedure of an accounting system ♦ Examining source documents ♦ Recording transactions in an accounting journal ♦ Posting recorded transactions ♦ Preparing financial statements © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. The Accounting Cycle (1 of 2) ►Journal ♦ A time-ordered list of account transactions ►Ledger ♦ A book or computer file with separate sections for each account © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Income Statement Income Statement ♦ A financial report that shows an organization’s profitability over a period of time – month, quarter, or year Revenue ♦ The total amount of money received from the sale of goods or services, as well as from related business activities Cost of Goods Sold ♦ The amount of money a firm spent to buy or produce the products it sold during the period to which the income statement applies © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Equivalent Terms in Accounting Term Equivalent Term Revenues Sales Goods or services sold Gross profit Gross income Gross earnings Operating income Operating profit Earnings before interest and taxes (EBIT) Income before taxes (IBT) Earnings before taxes (EBT) Profit before taxes (PBT) Net income (NI) Earnings after taxes (EAT) Profit after taxes (PAT) Income available to common stockholders Earnings available to common stockholders © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Gross Income and Expenses Gross Income (or Profit) Revenues minus the cost of goods sold required to generate the revenues The income available after paying all expenses of production Expenses The costs incurred in the day-to-day operations of an organization 1. Selling, general, and administrative expenses (including depreciation) 2. Research, development and engineering expenses 3. Interest expenses © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Depreciation The process of spreading the costs of long-lived assets such as building and equipment over the total number of accounting periods in which they are expected to be used 1.A manufacturer purchases a $100,000 machine expected to last about 10 years 2.Rather than showing an expense of $100,000 in the first year and no expense for the item over the next 9 years, manufacturer allowed to depreciation expenses of $10,000/year in each of the next 10 years 3.Better matches cost of equipment to years item is used 4.Depreciation is “written off” as an expense and book value of the machine is also reduced by $10,000 © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Net Income The total profit (or loss) after all expenses, including taxes, have been deducted from revenue; also called net earnings Most companies present the current year’s results along with the previous two years’ income statements Gross profit, earnings before interest and taxes, and net income are the results of calculations made from the revenues and expenses accounts; they are not actual accounts When corporation elects to pay dividends, it decreases the cash account as well as a capital account © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Balance Sheet A “snapshot” of an organization’s financial position at a given moment • Shows assets and the funding used to pay for these assets, such as bank debt or owners’ equity • Takes its name from its reliance on the accounting equation: assets must equal liabilities plus owners’ equity • An accumulation of all financial transactions since company’s founding • Traditional balance sheet places assets on the left side and its liabilities and owners’ equity on the right • Vertical format has assets on the top followed by liabilities and owners’ equity © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Balance Sheet - Assets Listed in descending order of liquidity – how fast they can be turned into cash Current Assets o Assets used or converted into cash within the course of a calendar year o Cash, temporary investments, accounts receivable and inventory Accounts Receivable o Money owed a company by its clients or customers who have promised to pay for the products at a later date © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Balance Sheet - Liabilities Current Liabilities o A firm’s financial obligation to short-term creditors, which must be repaid within one year Accounts Payable o The amount a company owes to suppliers for goods and services purchased with credit Accrued Expenses o An account representing all unpaid financial obligations incurred by the organization © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Balance Sheet – Owners’ Equity Owners’ equity includes: ♦ The owners’ contributions to the organization ♦ Income earned by the organization retained to finance continued growth and development Accounts listed as owners’ equity on a balance sheet may differ dramatically from company to company ♦ Corporations sell stock to investors, who then become owners of the firm ♦ Many corporations issue several different classes of common and preferred stock © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Pro Forma Financial Statements • Pro forma financial statements are used to make decisions about future operations changes within a company Include balance sheets, income statements, and cash flow statements. Pro forma financial statements will show o Whether profits will increase or decrease o The magnitude of expenses involved o Whether the company needs financing to facilitate the proposed change © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Statement of Cash Flows (1 of 2) • Explains how the company’s cash changed from the beginning of the accounting period to the end Balance sheet shows the cash account in one point of time; most investors want a better picture of how cash flows into and out of the company Statement of cash flows takes the cash balance from one year’s balance sheet and compares it with the next while providing detail about how the firm used the cash © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 34 Statement of Cash Flows (2 of 2) • Cash from operating activities – Calculated by combining the changes in the revenue, expense, current assets and current liability accounts • Cash from investing activities – Calculated from changes in the long-term or fixed asset accounts • Cash from financing activities – Calculated from changes in the long-term liability accounts and the contributed capital accounts in owners’ equity © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 35 Ratios • Ratio Analysis – Calculations that measure an organization’s financial health Brings complex information from the income statement and balance sheet into sharper focus To measure and compare the organization’s productivity, profitability, and financing mix with other similar entities • Profitability Ratios – Ratios measuring the amount of operating income or net income an organization is able to generate relative to its assets, owners’ equity, and sales © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 36 Financial Ratios A ratio is simply one number divided by another, with the result showing the relationship between the two numbers Financial ratios used to weigh and evaluate firm performance Whether numbers are good or bad depends on their relation to other numbers If a company earned $70,000 on $700,000 in sales (10% return) such an earnings level might be satisfactory The president of the company earning this same $70,000 on sales of $7 million (1% return) should probably start looking for another job © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Profit Margin Net income divided by sales Microsoft’s profit margin calculated by taking net income (net earnings) and dividing by sales (total net revenues) $21,863 million divided by $77,849 million equals a profit margin ratio of 28.08% For every $1 in sales, Microsoft generated profits after taxes of nearly 28 cents © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Return on Assets Net income divided by assets Microsoft’s return on assets calculated by taking net income (net earnings) and dividing by total assets $21,863 million divided by $142,431 million equals a return on assets of 15.35% For every $1 in assets, Microsoft generated a return of 15.34% or profits of $15.35 © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Return on Equity Net income divided by owners’ equity; also called return on investment (ROI) Microsoft’s return on equity calculated by taking net income (net earnings) and dividing by stockholders’ equity $21,863 million divided by $78,944 million equals a return on equity of 27.69% For every $1 invested by Microsoft stockholders, the company earns 27.69% return or $27.69 © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Asset Utilization Ratios • Ratios that measure how well a firm uses its assets to generate each $1 of sales Managers use asset utilization ratios to pinpoint areas of inefficiency in their operations These ratios – receivables turnover, inventory turnover, and total asset turnover – relate balance sheet assets to sales, which are found on the income statement © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Receivables Turnover Sales divided by accountants receivable Microsoft’s receivables turnover calculated by taking sales (total net revenues) and dividing by receivables $77,849 million divided by $17,486 million equals a receivables turnover of 4.45X Microsoft collected it receivables 4.45 times per year; which translates to about 80 days that receivables are outstanding © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Inventory Turnover Sales divided by total inventory Microsoft’s inventory turnover calculated by taking sales (total net revenues) and dividing by inventory $77,849 million divided by $1,938 million equals an inventory turnover of 40.17X Microsoft’s inventory turnover indicates they replaced inventory 40.17 times last year, or about every nine days © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Total Asset Turnover Sales divided by total assets Microsoft’s total asset turnover calculated by taking sales (total net revenues) and dividing by total assets $77,849 million divided by $142,431 million equals a total asset turnover of 0.55X Microsoft generated $0.55 in sales for every $1 in total corporate assets © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Liquidity Ratios • Ratios that measure the speed with which a company can turn its assets into cash to meet short-term debt High liquidity ratios may satisfy a creditor’s need for safety, but may indicate the company is not using its current assets efficiently Liquidity ratios are best examined in conjunction with asset utilization ratios because high turnover ratios imply cash is flowing through very quickly © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Current Ratio Current assets divided by current liabilities Microsoft’s current ratio calculated by taking current assets and dividing by current liabilities $101,466 million divided by $37,417 million equals a current ratio of 2.71X Microsoft’s current ratio indicates that for every $1 of current liabilities, the firm had $2.71 of current assets on hand © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Quick Ratio (Acid Test) A stringent measure of liquidity that eliminates inventory Microsoft’s quick ratio calculated by taking current assets minus inventory and dividing by current liabilities $99,528 million divided by $37,417 million equals a quick ratio of 2.66X In 2011, Microsoft’s had $2.66 of current assets (after subtracting inventory) for every $1 of current liabilities © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Debt Utilization Ratios Ratios that measure how much debt an organization is using relative to other sources of capital, such as owners’ equity Debt financing riskier than equity as it demands a monthly payment regardless of profitability Recessions affect heavily indebted firms far more than those financed through equity Companies tend to keep debt-to-asset levels below 5% © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Debt to Total Assets Ratio A ratio indicating how much of the firm is financed by debt and how much by owners’ equity Microsoft’s ratio calculated by taking debt (total liabilities) and dividing by total assets $63,487 million divided by $142,431 million equals debt to total assets ratio of 45% For every $1 of Microsoft’s total assets, 45% is financed with debt and 55% with owners’ equity © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Times Interest Earned Ratio Operating income divided by interest expense Microsoft’s times interested earned ratio calculated by taking EBIT (operating income) and dividing by interest (from note 3) $26,863 million divided by $429 million equals times interest earned ratio of 62.39X Microsoft paid $429 million in interest expense, but that amount was covered 62.39 times by income before interest and taxes © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Diluted Earnings Per Share (1 of 2) • Per Share Data – Data used by investors to compare the performance of one company with another on a equal, per share basis • Earnings Per Share – Net income or profit divided by the number of stock shares outstanding © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 51 Diluted Earnings Per Share (1 of 2) Microsoft’s diluted earnings per share calculated by taking net income and dividing by the number of shares outstanding (diluted) $21,863 million divided by $8,470 million equals a diluted earnings per share of $2.58 Microsoft’s basic earnings per share declined from $2.69 per share to $2.58, and this decline also shows up in diluted earnings per share © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Dividends Per Share The actual cash received for each share owned Microsoft’s dividends per share calculated by taking dividends paid and dividing by the number of shares outstanding $7,456 million divided by $8,103 million equals dividends per share of $0.92 Since 2004, Microsoft has raised its dividend every year, from $0.16 per share to $0.92 per share © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Importance of Integrity in Accounting The recent financial crisis and recession showed another example of a failure in accounting reporting Many firms attempted to exploit loopholes and manipulate accounting reporting Banks and other financial institutions often held assets off their books by manipulating accounts Transparency and accuracy in reporting revenue, income and assets develops trust from investors and other stakeholders © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Compliance to Accounting Principles Strong compliance to accounting principles creates trust among stakeholders ► Accounting and financial planning is important for all organizational entities even cities ► Integrity in accounting is crucial to: ◄ Create trust ◄ Understanding the financial position of an organization or entity ◄ Making financial decisions that will benefit the organization © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. Solve the Dilemma (1 of 3) Exploring the Secrets of Accounting You have been promoted from vice president of marketing of BrainDrain Co. to president and CEO ► You know marketing like the back of your hand, but know next to nothing about finance ► BrainDrain is in danger of failure if steps to correct large and continuing financial losses are not taken at once ♦ You asked vice president of finance and accounting for a complete set of accounting statements ♦ Statements detail the financial operations of the company ♦ You decide to attack the problem systematically and learn “hidden secrets” of the company statement by statement © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 56 Solve the Dilemma (2 of 3) Exploring the Secrets of Accounting Searching for answers – With the firm’s trusted senior financial analyst by you side, you delve into the accounting statements – Resolved to “get to the bottom” of the firm’s financial problems – Set new course that will take the firm from insolvency and failure to financial recovery and perpetual prosperity © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 57 Solve the Dilemma (3 of 3) Exploring the Secrets of Accounting Discussion Questions – Describe the three basic accounting statements. What types of information does each provide that can help you evaluate the situation? – Which of the financial ratios are likely to prove to be of greatest value in identifying problem areas in the company? Why? Which of your company’s financial ratios might you expect to be especially poor? – Discuss the limitations of ratio analysis. © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part. 58 Discussion ? ? ? ? Why are accountants so important to a corporation? What function do they perform? Describe the accounting process and cycle. The income statements of all corporations are in the same format. True or false? Discuss. Why are debt ratios important in assessing the risk of the firm? © 2016 by McGraw-Hill Education. This is proprietary material solely for authorized instructor use. Not authorized for sale or distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a website, in whole or part.